One Long, One Short

“You can get any style house you want. You can get wood. You can get brick. You can get stucco. Boy, can you get stucco.”

Groucho Marx,

on an early Florida land development project,

in “Coconuts”

Popularity is poison, as Eric points out above.

Today, I bring you a poison stock…and a possible antidote.

Since we always like to walk on the sunny side of the street here at the Daily Reckoning, we will begin by strolling over to a stock featured in this week’s Barron’s – Consolidated Tomoka. I believe I mentioned this company to you several months ago – as an example of a ‘darned cheap stock.’

If I did not, I should have. Because ‘darned cheap stocks’ can be as hard to find as congressional interns.

Greg Jahnke reports in today’s Prudent Bear that he subjected 2,000 companies to a series of simple value tests. They needed to be priced at less than 1 times sales. They needed a ROE of at least 15% over the past 12 months. And they could have debt equal to no more than 25% of capital. Only 45 companies passed the tests, or fewer than one in 40.

Tomoka was probably not even considered by Jahnke, because its value does not appear on its balance sheet. Instead, it lies in central Florida – including six and a half miles straddling Interstate 95.

In the same era in which tycoons spent huge sums to build Baltimore’s great mansions, the forefathers of Tomoka were buying scrub land in and around Daytona Beach for $125 an acre. Baltimore was popular at the time. Florida was not.

But Baltimore property peaked out – in real terms – before the crash of ’29. Daytona Beach, on the other hand, grew more popular with each passing winter – and got a huge boost after the Carrier company brought residential air conditioning to Florida in the 1950s.

Today, Tomoka’s 15,000 acres are worth more than they were 100 years ago…but are they worth more than is reflected in the stock price? At a recent price of $14.90 a share, Barron’s reports, “the market is saying the land is worth $5,570 per acre.” The difference between that number and the amount it could be sold for represents the ‘margin of safety’ and a measure of the potential profit from buying Tomoka shares.

“If you value all the property at last year’s average sales price – a hardly extravagant $34,215 an acre,” figures Barron’s, “the stock should sell at $91 a share.”

While we offer no opinion on the future of Florida land prices…we suspect that an investor has a much better chance of making money with Tomoka than he has with shares whose value is less close to terra firma.

One such company is IBM. Grant’s Interest Rate Observer notes that IBM’s CEO, Louis Gerstner, Jr., has been made a knight of the British Empire. One doesn’t see many knights on the streets of Manhattan any more. Sir Louis is an anachronism. But so is IBM. The company is priced as though there were still a bull market in technology.

IBM operates in 7 different, but related, technology industries: services, servers, semiconductors, storage, software, hosting and personal computers. In every one of these industries, the competitors’ stock prices have been knocked down by bad business conditions, but Sir Louis has been untouched except by praise. By agglomerating all these bad businesses together, could IBM have created a good one?

In software, for example, Goldman Sachs’ index has been cut in half over the last two years. But IBM is actually higher. The Nasdaq, too, has slumped to only half what it was 24 months ago, while IBM is stands as erect and tall as a Buckingham Palace guard.

Sun Microsystems, a competitor server company, trades at barely a quarter of what it did two years ago. Computer Sciences, which competes with IBM in the services market, is about 50% off. While EMC, a storage company, has lost 60% of its value.

Meanwhile, the competitive hosting firm, Exodus, must have left for the promised land…its shares are down 98% since the seas parted in March 2000. But, somehow, IBM has suffered no damage.

Laying itself out on a bed of quicksand, IBM has – so far – avoided sinking. The shares, which trade at 23 times earnings, are still as popular as a bum who just won the lottery.

Abby Joseph Cohen recommends the stock. That alone may not be reason to go short. But Big Blue announced layoffs last week, and more yesterday. And next week, IBM will report results for the last quarter. Most analysts and investors will accept IBM’s numbers without question. But a few may ask questions.

Sir Louis will need some very good answers.

Your correspondent…whose popularity has never been in question…

Bill Bonner
Baltimore, Maryland
July 12, 2001

Learn to like raw fish. That’s my advice.

“The financial assets of Japanese households fell in fiscal 2000 for the first time since 1964, the first year the statistics were recorded,” Eric reports.

“What policy option is available for Japan?” asks Kumhara Shigahara in the Japan Times. “…The world’s second-largest economy and is now undergoing the world’s most rapid process of population aging with projected huge increases in social expenditure – after years of fiscal stimuli that have already turned its public- sector debt position into the worst among advanced economies?”

Zero interest rates have failed to lure the Japanese into becoming spendthrifts. Billions in government spending have failed to ignite the economy. Neither a fiscal stimulus nor a monetary one has worked. What else is there?

The problem in Japan cannot be cured by central banks nor by central government. Because it is not a problem at all – but a fact of life, like the corrosion of base metals and politicians’ souls. Busts follow booms. And youth yields to maturity. Both of these circumstances have beset the Japanese economy and neither responds to rate cuts.

The Japanese are getting older. They been shaving expenses…saving money….and selling assets. That’s what older people do.

Could the same thing happen here? The NY TIMES, the WSJ, CNN, MONEY, WORTH, CNBC, Merrill Lynch, Alan Greenspan, Goldman Sachs, Abby Joseph Cohen, Henry Blodget, Paul Krugman, Michael Murphy, and practically every economist and financial analyst in the world says ‘no way.’

But here at the Daily Reckoning, we say, “who knows?” We don’t know. But we noticed that yesterday, on Wall Street, the indexes rose – but only 1344 stocks advanced on the NYSE, while 1747 declined. After two years of losing money, people are getting discouraged and selling stocks.

And we noticed something else too – the gap between inflation-indexed TIPS and 10-year T-notes has dropped to a new low – 1.82%…another signal of Japan-style deflation.

And, as reported yesterday, Americans are borrowing less money.

Are Americans beginning to act like the Japanese – shaving expenses, saving money, and selling assets? Maybe… Let’s see what Eric has to say:

*****

Eric Fry reports from the concrete jungle:

– Americans are an optimistic lot. And American investors, in particular, are experts in the art of making silk purses from sows’ ears. After Wall Street rang the closing bell yesterday, three well-known companies reported news of some kind: Microsoft, Motorola and Yahoo. Was it good news? Not exactly. But the silk purse manufacturers went right to work and all three stocks soared higher in after-hours trading.

– Before rushing in with the masses this morning to buy some of these popular stocks, consider what constitutes “good news” these days.

– Microsoft announced that its revenues for the quarter would be slightly higher than what it had previously predicted, somewhere around $6.5 billion. Nevermind that the company will take a $3.9 billion write-off to account for its losses in various venture capital investments and other equity holdings. Microsoft’s stock climbed 6% in after-hours trading.

– Motorola reported a quarterly loss of 11 cents a share. But hey, the loss was a penny better than the consensus estimate. Nevermind that cell-phone revenues dropped 25% and that its semiconductor sales plummeted 38% from the year-ago totals. The stock gained 5% after- hours.

– Yahoo, for its part, reported one whole penny per share in earnings instead of the breakeven result that Wall Street had predicted. Nevermind that revenues collapsed 33%. The stocks soared 8% after-hours.

– By comparison to the after-hours action, the regular trading day seemed fairly mundane. The Nasdaq Composite Index gained 9 points in the regular session and the Dow moved up 65 points to 10,241.

– It almost never pays to chase after popular stocks.

– “Popularity is poison,” cautions The Babson Staff Letter. “If, starting in 1982, an investor bought the most popular stock [defined by Babson as the highest PE stock on the NYSE] each year and held it up to today, the 19 stocks together would have earned only 40% as much as if yearly investments had been made in an S&P 500 index fund.”

– Notable losers on Babson’s “most popular” list include last year’s entry, Cisco Systems, and the most popular stock of 1998, Coca-Cola Enterprises. Since making Babson’s list, Cisco and CCE have produced losses of 73% and 67% respectively. I guess there’s a reason why the time-worn strategy for success on Wall Street is not, “Buy high, sell low.”

– With reports like this circling about…business isn’t exactly booming in my neck of the woods either. Wall Street profits fell nearly 40% in the second quarter from a year ago, according to a Securities Industry Association study released today.

– But it’s not for a lack of trying. A friend of mine who is an institutional stockbroker for a major Wall Street firm told me something very interesting last night. His firm’s “storage analyst” (i.e. the analyst who researches data storage companies like EMC and Brocade) had been telling clients to sell EMC several days before EMC’s recent earnings shortfall announcement.

– Why is this interesting? Because this same analyst rated EMC a “Buy,” even though he was telling some clients to sell. As my friend explains, “You’ve got to have a buy on something.” My friend added, “The analyst thinks that every storage stock he covers is an outright ‘sell.’ Pricing for storage is simply collapsing.”

*****

Back to Bill, in Baltimore, Maryland, hon…

*** Popularity does have some advantages. “In 2000, the TV series ‘Temptation Island’ was set in Belize,” Barbara Periello of IL Discovery Tours tells me. “Today property values have skyrocketed as much as 80% on Ambergris Caye. This year, FOX TV is taking their show to Honduras’ Bay Islands. We suspect there will be a similar, immediate boost in values.” (If you’re interested, you can join Barbara as she investigates potential sites first-hand this coming September… request more information by sending an e-mail to: tours@gate.net)

*** What’s going on in Baltimore? The city seems much livelier than before.

*** Elizabeth took the kids to visit her family in New York – leaving me alone in the city. I feel a little like Jack Lemmon in “The Seven Year Itch.” waiting for Marilyn Monroe to drop a flower pot. But the city is not that lively.

*** I went to look at a big, old rowhouse for sale yesterday in the historic Mount Vernon area. At $450,000 the price may be derisory in New York or San Francisco, but it is outrageous for Charm City. After a hundred years of declining in real terms, could Baltimore property have bottomed out?

*** And last night, I went out to dinner with some friends – we decided to try a new restaurant, but discovered that it was full! This never used to happen in Baltimore. We had to go to yet another new restaurant.

*** My friend, Thom, with whom I dined, is in charge of the company student intern quarters.

*** “Not a single intern has disappeared since I’ve been on the job,” he declared, proudly.

*** “But what about that German girl who fell down the elevator shaft,” I reminded him.

*** “Hey, that wasn’t my fault…”

*** Miraculously, the girl was unhurt and now works for our partners in Bonn.